Monday, July 18, 2011

PT - Paul Tustain on "In search of reliable scarcity"

The Economist and Gold - 31 May 2011

"...Gold offers humanity one exceptionally useful property; it has an extraordinarily stable stock. There are 166,000 tonnes of the stuff above ground (worth about 8 trillion dollars) of which about 88% is held as a value store of sorts, in jewellery (52%) and bullion (36%). The stock is growing by about 1.5% a year, from the combined efforts of all the world's miners.

[Mrt: In Asian countries jewellery is another way of savings bought by weight rather than art properties]

that it has this reliable stock quantity.Nothing else can do it; not silver, which is 80 times more common in the ground, nor platinum, which is far too useful as a catalyst to offer stock stability.

Reliable scarcity is the key property savers require of money, which otherwise fails to store value.But of course we don't need gold to deliver reliable scarcity, we can usually create that reliable scarcity artificially, as we do with our modern currencies.

Now the marginal utility explanation. When new currency is too freely issued reliable scarcity becomes under-supplied, andsavers go in search of it. Having seen artificial reliable scarcity fail in one currency, the promise of it in another is unconvincing, so they turn to natural reliable scarcity, and demand for it increases dramatically as governments print money. This is what drives gold up. Mr Sandberg is right though, that it will eventually go down again, when currencies' artificial scarcity once more becomes reliable, and when those currencies start to generate a yield..."

[Mrt: Is this last blue sentence true? or will new Fofoa´s higher level hold? Time will tell. Utility for savers and a hard lesson will teach us I believe. Then freegold as a possible outcome?]

"...The question, therefore, is whether the savers who own 100 trillion dollars of dated debt instruments in the bond markets will take fright at continuing money printing policies of the US and other governments. That 100 trillion of dated debt has already started running down the clock. It is shifting to the short end, where it behaves more and more like cash..."

As FOFOA says, it's not the stock that matters so much as the flow. New supply = flow, before it becomes stock (or continues to flow, perhaps).

I think this question is more about expectations of purchasing power for the future, rather than current aboveground stock and the rate of increase of the same.

If expectations of purchasing power (in terms of goods, let's say CPI or HICP index increase) for currency are stable (say ~2% or so that is the "natural" rate that we expect to see) then we will be happy to hold this currency rather than dispose of it for alternatives as quickly as possible. This expectation of stable purchasing power is a feedback loop - while it turns out to be correct, that can mask a much larger supply that is being backed up behind the savings wall -- there can be a much more significant level of addition to the "aboveground stock of the currency", but as long as the expectations are the purchasing power is stable it's all good and the purchasing power does remain stable.

However, if more people begin to believe that perhaps the purchasing power isn't going to be stable going forward after all, and they begin to release their savings stock into the flow through the economy, this increase in velocity of the currency in question will impact on the prices of all other goods and services. This again is a feedback loop: as more and more people release their money from behind the savings wall, prices rise, and more people notice and do the same. So, this is how as FOFOA again says, the hyperinflation of the dollar has already taken place in the past — there are many, many dollars locked up behind the savings wall already, waiting for more and more people to come in waves to release them in order to buy something else with them, that they feel they either need to consume now or in the near future, or perhaps more likely that they feel will be a more stable and superior store of value. This might be another currency, or perhaps something like gold. Past inflation, which was hidden at the time, steps out into the open for all to see.

There is an obverse to this as well, if the amount of flow turns down and even goes negative (oversaving). This creates again an expectations feedback loop, where people expect prices of goods and services to fall so they keep back cash they would normally spend into the economy. The more people do this, the lower the velocity of the currency goes and the further prices of goods and services fall, the more people see it and stop spending, etc. This is hard to escape (see 1930's, Japan) and will be avoided at all costs if at all possible.

The difference between any paper currency and gold (or some other tangible, scarce physical item), is the small matter than mother nature dictates there cannot be an inflation of the total aboveground stock each year in excess of ~2%; it is simply impossible for that to be hidden behind the savings wall unnoticed, due to the physical inability to perform such an expansion of supply. I suppose it is, however, possible for there to be an expectation of this 2% increase passing through flow into stock, and it just doesn't materialise — however realisation this turned out to be the case would most rationally present itself as a hoarding of existing gold (flow moving to stock), on expectation of increasing purchasing power. (Another feedback loop process.) Hardly a problem for the sort of people that buy gold; their intentions are to maintain or improve their purchasing power, very few people buy it as an input to their manufacturing of goods and services. So nobody gets hurt by this situation, either you are unaffected or you benefit.

Gold DOES expand in aboveground stock by ~2% per year, and its purchasing power therefore WILL be stable.

Paper currency aboveground stock expanded far in excess of ~2% per year, but the FLOW did not. So there are stable EXPECTATIONS for purchasing power. Until there isn't and velocity takes over the show. Then people will flee the currency as they see its purchasing power increasingly decline against the alternative stores of wealth. Other economies will not want to see their economies choke on rapid deflation, so they will debase along with each other in the race to the bottom. Everybody wants their currency to stay within the 0%-2% purchasing power sweet-spot, to prevent both an inflation and a deflationary death spiral from taking hold.

This all adds up to a global focus onto gold as the store of value par excellence, as the only "money" that isn't in the race to the bottom. The last reliable, globally recognised, store of value left standing.

This is what drives gold up. Mr Sandberg is right though, that it will eventually go down again, when currencies' artificial scarcity once more becomes reliable, and when those currencies start to generate a yield..."

I expect gold to rise in currency terms significantly from today's levels, as the debt problems of the entire world are reset through currency debasement. Gold will be the tool to achieve this; gold will be repriced in currencies, and therefore everything but gold will be devalued.

Once that process has completed, however, I expect the rise in value of gold to halt. Either, depending on the management policies of each monetary authority, they will achieve a stable rate of exchange against gold (the global benchmark of value all currencies are measured against), or they will choose instead to continue to inflate their currencies (and probably in the process abandon hope of attracting foreign investment at attractively low rates of interest).

As Paul Tustain asserts above, (some) currencies may become once again more attractive than gold as a store of value, IF they are managed responsibly and maintain a stable rate of exchange against gold, AND they provide a yield -- making the holding increase in value compared to gold, over time. Confidence will be key to achieving this outcome for any CB though. Only time will tell for sure if this theory can be proved into reality later.

This also implies that beyond the repricing transition, it will not be important to the man in the street that he can access 0.1g gold coins that are affordable to him. The currency he is paid in will be stable, or if that is not the case some other global paper currency will be an attractive savings option open to him. Gold will no longer be rocketing up though.